A mortgage refinance can help lower your monthly mortgage payments and free up cash in your budget. Or you can shorten the loan term and pay your mortgage off faster or potentially tap into your home equity to access cash. But before applying, you should understand what lenders expect from borrowers and how to best position yourself to get approved for a new loan with competitive terms.
This guide explores the specifics of mortgage refinance requirements and how the lending process works. It also discusses the importance of meeting mortgage refinance requirements, why your DTI, income and home equity matter when refinancing, and special requirements for select types of mortgage refinances.
Understanding the Requirements for Mortgage Refinance
Before diving into the specifics of mortgage refinance guidelines, familiarize yourself with how the process works. That way, you’ll know what to expect and can confidently navigate the lending process.
Overview of Mortgage Refinancing
A mortgage refinance is a strategy that involves applying for a new home loan, preferably with more competitive terms, and using it to replace your current one. If approved, the lender uses the loan proceeds to pay off your existing balance, and you begin making payments towards the new home loan.
Many homeowners refinance to make their monthly mortgage payments more affordable, either by extending the loan term, securing a lower interest rate or both. Others prefer to own their home outright sooner rather than later and apply for a new home loan with a shorter term. And then there are homeowners who’ve built up a substantial amount of equity and want to leverage it to meet pressing financial goals.
You can also refinance to remove a cosigner from the loan.
The Importance of Meeting Refinance Requirements
There are general guidelines to meet if you want to qualify for a mortgage refinance. Each lender also has its own requirements that could be a bit more stringent, so you want to inquire before applying.
But you could be denied funding if you’re in the dark about refinance requirements or apply despite not meeting the mark. And if the lender does make an exception and approves your loan application, the terms may not be enticing enough to beat out what you currently have.
What Are the Basic Requirements to Qualify for a Mortgage Refinance?
Lenders take a look at your credit score, home equity, income, employment history and debt-to-income (DTI) ratio. The value of your home, which is confirmed through a professional home appraisal, also plays an important role in your eligibility for a mortgage refinance.
Credit Score Requirement
Most lenders prefer a score of at least 620 to consider you for refinancing, but this figure could go as low as 580 if you’re seeking an FHA loan.
Significance of Credit Score in Mortgage Refinance
Your credit score plays a major role in the rate you’ll receive if you qualify for a mortgage refinance. Keep in mind that refinancing with the lowest acceptable credit score may not be ideal, as you likely won’t qualify for the best terms the lender offers.
How to Improve Your Credit Score for Refinancing
If your credit rating isn’t quite up to par, look at your credit report to ensure it’s free from inaccuracies that could drag your score down. Copies of your reports from the three credit bureaus – Experian, TransUnion and Equifax – are accessible weekly free of charge at AnnualCreditRepot.com. If you spot errors, promptly dispute them with the respective credit reporting agencies.
Also, check your payment history and work with creditors and lenders to bring any past-due accounts current. If possible, pay down your credit balances to lower your credit utilization rate. Don’t close any old accounts and avoid applying for new credit.
Home Equity Requirements
Ideally, you should have at least 15 to 20% in home equity to avoid Primary mortgage insurance (PMI).
Understanding Home Equity
Home equity refers to the amount of your home you own outright. For example, if your home is worth $375,000 and you currently owe $250,000 on the mortgage, you have $125,000 or a little over 35%, in home equity.
Role of Home Equity in Mortgage Refinance
A considerable amount of home equity generally means you’ll qualify for more attractive terms, assuming you meet the other lending requirements.
If you’re seeking a cash-out refinance, the amount of equity determines how much money you can pull out of your home. If you aren’t familiar with how it works, a cash-out refinance lets you borrow more than you currently owe and receive the difference in cash.
The amount you can access is based on home equity. For example, if the lender lets you take out up to 80% in equity, here’s how a cash-out refinance would work using the example above:
- $375,000 (home value) * .80 (percentage of equity accessible) – $250,000 (mortgage balance) = $50,000
- Cash-out: $50,000
- New home loan: $300,000 ($250,000 + $50,000)
Income and Employment Requirements
Lenders want reassurance that you can afford to make timely monthly payments on the new home loan.
Required Proof of Income and Employment
To prove you have a consistent and reliable income source, lenders generally request:
- Two most recent pay stubs
- Tax returns and W-2s from the past two years
- 1099 forms from the past two years and a CPA letter verifying your employment status if you’re self-employed
- Documentation to substantiate other forms of income (i.e., government benefits, child support, alimony)
How Employment Status Affects Mortgage Refinance
If you have significant gaps in your employment history or only work part-time, you may have to overcome more hurdles to get approved. Self-employed borrowers should also prepare to provide additional documentation, including financial statements if the lender requests it.
The lender may also request further documentation or an explanation if you recently changed employers but work in the same industry or have changed career paths in the past two years.
Debt-to-Income Ratio
A debt-to-income (DTI) ratio below 43% is preferred for most loan programs, but you could get approved if it’s higher if there are other compensating factors.
Understanding the Debt-to-Income Ratio concept
Your DTI is the percentage of monthly gross income used to cover monthly debt obligations. So, if you earn $7,000 and pay creditors and lenders $2,500 each month, your DTI is 35.7%.
Effect of Debt-to-Income Ratio on Mortgage Refinance
The lower your DTI, the more likely you are to qualify for attractive loan terms. But if it’s on the higher end, you could still get approved and secure a reasonable interest rate if you have a strong credit score.
Requirement of Home Appraisal
Home appraisals are mandatory for most mortgage refinance transactions.
What is Home Appraisal?
A home appraisal is a term used to describe a professional analysis conducted by a licensed appraiser to determine the value of your property. Several factors, including the size, location and condition of your home, are used to come up with this figure. Sales history in your local area also plays a role in the valuation of your home.
Why is Appraisal Necessary in Mortgage Refinance?
Lenders use home appraisals to confirm they aren’t lending more than the property is actually worth. In some cases, the results can impact your loan approval and require you to bring more money to the table to get approved. Or you could be stuck paying PMI if the loan-to-value (LTV) ratio indicates you don’t hold at least 20% in equity.
Special Mortgage Refinance Requirements for Some Refinance Types
Again, the guidelines referenced here are generic and may not apply to all lenders. It’s worth consulting with the lenders you’re considering to learn more about their unique requirements.
If you’re considering a government-backed mortgage refinance, like an FHA Streamline or VA Streamline refinance, you’ll find that the requirements are far less stringent. Neither of these loan products imposes minimum credit score or income guidelines and doesn’t require an appraisal.
Conclusion: Final Takeaways on Mortgage Refinance Requirements
When you’re ready to refinance your mortgage, explore the options and weigh the pros and cons to find the best fit. You also want to run the numbers to ensure the benefits of refinancing outweigh the costs to help you make an informed decision. Most importantly, confirm you meet the requirements to avoid major hiccups or, even worse, a denial during the application process.
FAQs About Mortgage Refinance Requirements
You must meet credit score, income, home equity, LTV and DTI requirements to qualify for a mortgage refinance. Failure to do so may result in a denial unless there are other compensating factors or the lender is willing to work with you.
Although the options are limited, some programs, like the FHA Streamline Refinance, could work for you.
